For many wealthy families, transferring assets during life from one generation to the next is a basic element of estate planning. There are a number of reasons why the transfer of assets during life is often preferable to testamentary transfers, from both tax and managerial perspectives. From a tax standpoint, making lifetime gifts allows a parent to remove the income, value, and growth attributable to the gifted asset from the parent’s taxable estate. In addition, because many states impose a separate estate tax, but only Connecticut and Minnesota impose a separate gift tax, one may reduce the effect of state estate taxes at death by making taxable gifts during life. There are also many nontax reasons why families prefer making lifetime transfers rather than passing assets at death. Parents can take comfort in seeing to it that their children learn how to handle investments, or manage a family business, before they have passed away. Older parents may prefer making transfers during life because they no longer feel comfortable managing a large percentage of their family’s assets, or they may simply want to be around to watch their children enjoy the increased standard of living that the gifts provide. Whatever the motivation, lifetime transfer planning is a dominant aspect of the estate planning process for many wealthy families.

Although lifetime transfer planning is an important agenda item for many wealthy families, there are significant attendant risks. From a transfer tax standpoint, one of the main risks arises when a person transfers assets that are difficult to value: the IRS, or the state tax authority, may challenge the value of the transferred property as reported by the transferor on the gift tax return. Such challenges are not uncommon, because transfer planning often involves the transfer of assets that are not easily marketable and that are, therefore, hard to value. The risk resulting from a successful valuation challenge by the IRS is that the transferor will be subject to the greater gift tax, as well as interest and potential penalties. IRC § 6662.